The Central Bank of Nigeria’s long-standing bouts of unorthodox policies has been put under the spotlight once again by its latest move to step in to fill the demand gap created by an earlier policy that imposes restrictions on the purchase of its short-term securities.
In a first-of-its-kind move, the Abuja-based bank says it would now act as a buyer of last resort for Open Market Operations (OMO) bills when sellers are unable to find buyers in the secondary market, according to a Friday, November 8 circular seen by BusinessDay.
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“As part of our liquidity management function, the Central Bank of Nigeria will be in the market on a daily basis to enhance the liquidity of the CBN instrument (OMO bills) by providing market-related quotes across all tenors,” the circular read.
The circular then said the CBN would provide quotes on a one-way basis to purchase instruments from the market. It noted that the Deposit Money Banks (DMBs) are expected to perform their market-making function and can only come to the CBN as a last resort.
The CBN’s move to step up as a buyer of last resort in the OMO market comes after the restriction is placed on non-bank firms and individuals from participating in the market, reducing active players to only the Deposit Money Banks and foreign investors.
Prohibiting every investor save for the banks and foreign investors from playing in the OMO market meant the CBN was cutting off a large chunk of the demand side.
Non-bank firms and individuals held 26 percent of the outstanding OMO bills (N3.7 trillion of N13.8 trillion) as of August 2019, while foreign investors held N6 trillion. The DMBs held N3.8 trillion.
Cutting off such a big chunk of demand has reduced one of the most vibrant and liquid asset classes in Nigeria’s capital market to a frozen and illiquid asset with dire consequences for the economy.
“The CBN wants to now act as the market maker or liquidity provider in the OMO market since it has taken out some big drivers of demand,” said Johnson Chukwu, CEO of Lagos-based asset management firm, Cowry Assets, whose firm is one of the parties now banned from investing in OMO bills.
“Once the liquidity of an instrument is dependent on the regulator, it tends to have a negative effect on investor confidence and typically leads to a reduction in the flow of capital,” Chukwu said.
According to Chukwu, if the flow of capital into Nigeria reduced, it would adversely affect the CBN’s external reserves as well as cause problems for the exchange rate and inflation.
The general feeling of five economists and money managers interviewed was no different. They said the CBN was stifling the free flow of market principles in a reminder of how the foreign exchange market was distorted in 2016.
“It was always clear that freezing dominant players in the OMO market would break the market, create illiquidity and spook investors fearing they may be stuck whenever they tried to exit,” said Wale Okunrinboye, head of research at fund manager, Sigma Pensions.
“The CBN’s solution to managing that illiquidity is flawed because there’s no way it doesn’t dent foreign investors’ confidence, especially when they think back to what happened in 2016 when the CBN tried and failed at being the sole provider of liquidity in the FX market,” Okunrinboye said.
In 2016, when the fall in crude oil prices and production saw dollar inflows slow to a trickle and put pressure on the exchange rate, the CBN defended an artificial currency peg of N199 per US dollar, assuring investors it could meet their dollar demands at that price.
Some 18 months and $7 billion in unmet dollar demand after, the CBN abandoned the peg, which paved way for an initial 40 percent naira devaluation.
On the evidence of a failed attempt at distorting an efficient market structure in 2016, the CBN’s move to act as a market maker in the OMO market has come as a surprise to investors and fund managers.
“The CBN is again assuring foreign investors that it will buy their OMO holdings and provide liquidity if there are no buyers but investors will always choose a market structure in place of one where there’s over-interference by the regulators,” said Ayodeji Ebo, managing director, Afrinvest Securities Ltd.
“That the CBN is tampering with a market structure again shows little lessons learnt from 2016,” Ebo said. “It will be interesting to see how investors respond this time, but it would be no surprise if they took a walk at maturity.”
The high-yielding OMO market has evolved over time from a market only open to local lenders into one that has been opened to other types of investors and has served as a conduit for foreign inflows necessary to keep the naira stable for the past three years.
But to manage ballooning interest expenses and discourage banks from giving loans to clients who use them to buy the securities, the CBN decided to put a stop to it using the latest restrictions.
The frequent OMO auctions by the CBN led to a record high N2 trillion on interest payments in 2018. This compares with an interest expense of N1.3 trillion in 2017 and N459.3 billion in 2016.
But whether the CBN can effectively cover for the parties now restricted from the market remains to be seen.
One positive development from the policy, however, is that it looks poised to reduce the government’s borrowing costs.
This is because investors barred from the OMO market are now piling into government bonds, with average yields collapsing to an 18-month low of 13.03 percent on Friday since the October 23 directive.
Traders say investors who no longer have access to a wide range of assets after the CBN’s restriction on the purchase of OMOs are resorting to bonds and that yields will fall further in the coming weeks and months.
The restriction also forces financial advisers to raise their game and come up with investible vehicles for the large chunk of cash to be freed up by the policy.
